Roth IRA vs. Mutual Fund: Key Differences

A Roth IRA and mutual fund serve different purposes and appeal to varying investment strategies. A Roth IRA is a retirement account that offers tax-free growth and withdrawals during retirement, provided eligibility criteria are satisfied. On the other hand, mutual funds are collective investment products that combine funds from numerous investors to build a diversified portfolio of assets, such as bonds or stocks. Knowing the differences between a Roth IRA vs. mutual fund can help investors select the option that best supports their financial goals.

There are lots of choices to make when building an investment portfolio, and a financial advisor ’s insights can be helpful during this process.

What Is a Mutual Fund?

A mutual fund represents a pooled investment in which multiple investors combine their money into a basket of securities. That typically means stocks and bonds, though mutual funds can also hold real estate investments, commodities or precious metals.

Investing in a mutual fund is different from purchasing an individual stock or bond. Instead of just one security, you can gain exposure to many, which can help with diversification. The cost of investing in mutual funds is typically measured in terms of the expense ratio. This represents what investors pay to own a mutual fund every year, expressed as a percentage.

Mutual funds can follow an active management or passive management strategy. With actively managed funds, a fund manager regularly reviews the fund’s holdings and decides when to sell off investments or add new ones. These mutual funds can have a higher expense ratio as a result.

Passive management is more hands-off with less turnover of fund assets. An index fund, for example, usually follows a passive strategy as its goal is not to beat the market but to match the performance of a specific index or benchmark, such as the S&P 500. Passive funds can produce consistent returns over time, often with lower expense ratios.

What Is a Roth IRA?

A Roth IRA is a tax-advantaged account \ designed to be used for retirement savings.

There are some key features that distinguish a Roth IRA vs. a taxable brokerage account, including:

Annual limits on contributions
Income-based eligibility
Tax treatment of withdrawals

With a brokerage account, you are free to contribute as much as you like in any given year. A Roth IRA, on the other hand, is subject to annual contribution limits set by the IRS.

The same is true for its traditional IRA counterpart. For tax year 2025, the annual cap on contributions to either type of IRA is set at $7,000, with an additional $1,000 catch-up contribution allowed for people ages 50 or older.

Your Roth IRA contributions depend on your tax filing status and income.

For 2025, single filers and heads of households with an modified adjusted gross income (MAGI) of under $150,000 can make a full Roth IRA contribution.
Those with a MAGI of $165,000 and above lose the ability to contribute to a Roth IRA altogether.
Married couples filing jointly with an MAGI of less than $236,000 can make a full contribution.
Those with MAGI above $246,000 can no longer contribute to Roth IRAs.

Perhaps, the best feature of a Roth IRA are the tax-free qualified withdrawals because these accounts are funded with after-tax dollars. Since you already paid tax on the money when you added it to your Roth IRA, you do not have to pay it again when you take that money out. And, unlike a traditional IRA, you are not required to take minimum distributions from a Roth IRA once you reach a certain age. Early withdrawals, however, may be subject to early withdrawal penalties and ordinary income tax.

Roth IRA vs. Mutual Fund: Which Is Better?

Piggy bank with "mutual funds" sign above it.

The most important thing to know about investing in a Roth IRA vs. mutual fund is that they are not mutually exclusive.

A mutual fund is a type of investment that is important when choosing your asset allocation. A Roth IRA is one place you could keep that type of investment. In other words, it is an option for asset location. It is possible to build a portfolio of mutual funds inside a Roth IRA, alongside investments you may own in a 401(k) at work, a taxable brokerage account or even a health savings account (HSA).

The type of mutual funds you can access will largely depend on where you open a Roth IRA. You can open a Roth IRA with any of the following:

Online brokerages
Mutual fund companies
Banks and credit unions
Insurance companies
Direct stock purchase plans

Any of those could allow you to purchase mutual fund investments.

However, some of these entities may offer Roth IRA CDs instead of a traditional Roth IRA. A Roth IRA CD is a certificate of deposit account that enjoys the tax features and benefits of an IRA. Although CDs are generally considered some of the safest investments, you may not earn the same returns with a Roth IRA CD that you would with a regular Roth IRA that is invested in mutual funds and other securities.

How Roth IRAs and Mutual Funds Work Together

A Roth IRA is not itself an investment but rather an account that can hold a range of assets, including mutual funds. This setup allows investors to use mutual funds as a vehicle for diversified investing within a tax-advantaged structure. Instead of purchasing individual stocks or bonds, investors can gain exposure to multiple asset classes through mutual funds held inside a Roth IRA.

Holding mutual funds in a Roth IRA means that any growth, dividends or capital gains generated by those funds can potentially be withdrawn tax-free in retirement. This makes the combination useful for long-term investment strategies where compounding and reinvestment play a key role. Investors do not need to pay annual taxes on distributions or gains, which may enhance long-term returns compared to holding the same mutual funds in a taxable account.

Another advantage of using mutual funds within a Roth IRA is simplicity. Many target-date or balanced mutual funds offer a pre-set mix of assets that adjust over time, which may appeal to investors looking for a hands-off strategy. These all-in-one funds can align with a retirement timeline and automatically adjust the risk exposure as retirement approaches, all within the Roth IRA’s tax-free growth environment.

Invest With a Roth IRA and Mutual Funds

If you are interested in opening a Roth IRA, first make sure that you are eligible based on your income and tax filing status.

If you are within the MAGI guidelines, the next step is choosing where to open your account. Of the options listed above, an online brokerage may be the easiest way to get started. You can also open a taxable brokerage account at the same time, which means more opportunities to invest in mutual funds.

When choosing mutual funds for a Roth IRA, tax efficiency and turnover ratios matter. An actively managed fund that frequently turns over assets and triggers capital gains events could be a good fit inside a Roth IRA. Since your IRA is tax-advantaged already, this can help minimize your investment tax on gains. A passively managed index fund or an exchange-traded fund (ETF) on the other hand, could be a better fit for a taxable brokerage account.

As mentioned, passively managed mutual funds tend to have lower turnover already. An ETF is a fund that trades on an exchange like a stock. These can also have active or passive management strategies. By keeping passively managed funds or ETFs in a taxable brokerage account, you can potentially minimize your tax liability on gains.

Bottom Line

If you are weighing a Roth IRA vs. mutual fund for investing, keep in mind that it does not need to be one or the other. You can use both to invest for the long term. The key is understanding the difference between asset location and asset allocation and how the two work together.

Ask a financial advisor about investing in a Roth IRA vs. mutual fund based on your personal long-term goals and portfolio holdings.

Tips for Investing

A financial advisor can help you craft a plan for investing, both within a retirement account and outside of one. Finding a financial advisor doesn’t have to be hard. SmartAsset’s free tool matches you with up to three vetted financial advisors who serve your area, and you can interview your advisor matches at no cost to decide which one is right for you. If you’re ready to find an advisor who can help you achieve your financial goals, get started now.
If you invest outside of a retirement account, you’ll want to keep capital gains taxes in mind as you make investment decisions. SmartAsset’s capital gains calculator can help you estimate how much you may owe in taxes when you sell an asset.